Lenders offer many different types of loans to accommodate a wide range of property types and borrower circumstances. If you're purchasing a single-family home as your primary residence, for example, your loan will probably be very different from the loan for a small apartment building purchase. Similarly, the type of loan you'll use as a first-time home buyer will likely be very different from what a retired borrower will use to purchase her retirement home. Lenders have created different types of loans to accommodate the needs of most borrowers. Here are a few of the options:

Conforming, conforming jumbo, and jumbo loans

Each year the Federal Housing Finance Administration sets conforming loan limits. For 2008 , the limit is $417,000 for a single-family home. (The conforming limits for 2-4 unit properties are higher.) Loans for this amount or less are considered to be conforming loans. Fannie Mae and other quasi-governmental organizations such as Freddie Mac purchase conforming loans from lenders and package them into securities that are then sold in the open market. This securitization of mortgages provides lenders with replenished funds to make additional loans. Conforming loans often have more flexible guidelines, which means that they're easier for borrowers to obtain.

Starting in 2008 a new category of loans, conforming jumbo loans, was created as part of the economic stimulus legislation passed by Congress over the last two years.  These loans were created to use the liquidity crisis for loans over the current conforming limits. Because Fannie Mae could not buy loans larger than $417,000, and because the crisis in the mortgage markets pushed investors out of the secondary market for jumbo loans, rates for loans over $417,000 skyrocketed. To ease the situation and reintroduce liquidity to the market, Congress allowed Fannie Mae to purchase loans of up to $625,500.  Rates for these loans are only slightly higher than for traditional conforming loans.

"Jumbo loans" are made for an amount in excess of the conforming limit. Interest rates for jumbo loans are generally much higher than for conforming and conforming jumbo loans in today's market. However, there are a limited number of lenders that still have good rates on jumbo loans.

Fixed and adjustable-rate mortgages

Fixed-rate mortgages carry an interest rate that does not change throughout the entire term of the loan. The most popular fixed-rate mortgage has a term of 30 years.

Adjustable-rate mortgages (ARMs) carry an interest rate that is fixed for only a portion of the term of loan. The period during which the rate is fixed can be as short as one month or as long as the first 10 years of a 30-year term. ARMs generally carry a lower rate of interest than fixed-rate mortgages. After the fixed period expires on an ARM, the interest rate will adjust once every six months or one year according to a formula. The formula takes an underlying index value and adds that value to a specified margin over the index in order to arrive at a new rate for the loan. ARMs carry periodic and lifetime "caps" that limit how high or low the interest rate can go during the adjustable period of the loan.

Fixed-rate mortgages work well for people who plan to stay in their home for many years. ARMs work well for people who will most likely move within a few years. If you plan to move within a few years of purchasing a home, it doesn’t make sense to sign on for the higher rate of interest associated with a fixed rate loan. You'll only need the interest rate to be fixed for the amount of time you own the property. In addition, because they usually carry a lower interest rate, ARMs will offer a lower monthly payment. If you're having trouble qualifying for a purchase, an adjustable-rate mortgage may work well for you, since the smaller monthly payment will allow you to qualify for a larger loan.

Interest-only and amortizing mortgages

Amortizing mortgages. With amortizing mortgages each monthly payment includes both principal and interest. Principal is the money you borrow from the lender. The lender requires that you repay its money according to an amortization schedule. The word amortization comes from the French word "mort" which means death or dying. Every time you make a mortgage payment some portion of the debt you owe the lender is "dying"!

Interest is the price the lender is charging you for borrowing its money. Each mortgage payment on an amortizing loan includes some interest. The amortization schedule is set up so that during the early years of the loan your monthly mortgage payment consists mostly of interest. Towards the end of the loan most of your monthly payment is principal. Although the amount of interest and principal you pay changes every month, your mortgage payment will remain the same provided you have a loan with a fixed rate of interest.

Interest-only mortgages. Some loans come with the option to pay ONLY the interest each month. Normally, mortgage payments are amortized, which means that they include both principal (the original amount borrowed) and interest. Interest-only payments on a loan will be significantly lower than amortized payments at the same rate of interest because they do not include principal repayment. Interest-only mortgages also offer flexibility: you can choose to pay the lender only the interest owed, or you can pay principal as well. This type of mortgage is usually easier to obtain because the required monthly payment – the interest – is lower than a fully amortized payment. However, interest-only mortgages specify that you must begin repaying principal at some point during the life of the loan. (You cannot continue to make interest payments alone throughout the entire life of the loan!)

Payment option mortgages. Also known as "negative amortization" loans, payment option loans provide the most flexibility because they allow you to make one of four payments each month: an interest-only payment, a fully amortized payment (over a 15 year term or 30 year term), or a minimum payment. The minimum payment required can be very low, but it also carries the risk of not meeting the minimum interest payment required for the month. If this is the case, the amount of interest not paid for the month is added to the loan principal balance. This means the loan has negatively amortized (the principal balance has increased). Payment option loans are usually one month ARMs -- the interest rate adjusts each month based upon an underlying index and a margin over that index.

Currently, lenders are not offering payment option ARM's. Although these loans work well for some borrowers, many property owners got into trouble when the initial fixed period of their payment option loans expired and their interest rates increased dramatically. In many cases, these borrowers did not receive an adequate explanation of how these loans work when they applied for them.

Documentation options

Because lenders realize that people earn their livings in different ways, they have created loan programs that allow different levels of documentation as proof of income.

Full documentation. Normally, lenders request that you provide documentation such as pay stubs, W-2s and tax returns that verify your monthly income, as well as additional documentation that verifies your assets. If you are able to comply with these requirements, you can submit your loan application to the lender on a “full documentation” basis. Your “reward” for providing full documentation: the best interest rates and terms available.

Stated income. Stated income programs allow you to tell the lender how much you make each month without providing documentation to support your income. Stated income programs work well for self-employed borrowers because people who run their own businesses tend to incur large expenses that minimize reported income on their tax returns. As a self-employed individual you may find it advantageous to claim a smaller income on your tax returns. This practice works against you, however, when you attempt to qualify for a loan.

Stated income loans provide a way around this predicament and are available to salaried borrowers as well. Certain minimum credit guidelines must be met in order to qualify for a stated income loan and the interest rate will usually be slightly higher than for a full documentation loan.  

Note: stated income loans are available only on a very limited basis currently.

Down payment options

Lenders prefer that you invest your money alongside theirs. If you don't contribute your own money toward the down payment, the lender becomes the only party at risk if you're unable to pay your mortgage. For this reason, your loan terms and interest rate will generally be more favorable when you make at least a 20% down payment.

If you make only a small down payment, or none at all, the lender perceives its risk as being higher and will ask to be compensated for this risk by charging a higher rate of interest (and possibly offering more restrictive terms). Down payment options can be broken down as follows:

20% down payment. If you make a 20% down payment toward your purchase, the lender finances the remaining 80%. With a 20% down payment you'll get the best terms and interest rate on your loan. A down payment larger than 20% may give you an even better interest rate!

10% down payment. If you make a 10% down payment, the lender finances the remaining 90%. However, when the loan constitutes more than 80% of the value of the property, lenders require that you insure them against the possibility that you will be unable to make your loan payments. This insurance is called mortgage insurance.

5% down payment. 5% is the smallest down payment option that lenders offer. If you're only able to contribute something less than 5% of the purchase price, you're better off saving your money for closing costs and possible improvements to the property.

Please note: a very limited number of conforming loans currently allow a 5% down payment in today's market. If your first loan is larger than $417,000 you'll need to make at least a 10% down payment.

 
Gifts. It is possible for someone else to give you money for your down payment. Lenders require that borrowers supply a “gift letter” showing the donor name and relationship to you -- the donor should be a family member -- and how much money she will provide. In addition, the gift letter must state that the donor is not requesting that you repay the gift.

When using a gift, lenders require that you, the borrower, contribute at least 5% toward the down payment. The rest of your down payment may come from gift funds. However, if the gift you're receiving is for 20% or more of the purchase price, you are not required to contribute any funds toward the down payment.

Second Loans

If you're making less than a 20% down payment towards your purchase you'll need a second loan. A second loan will provide you with financing for the difference between the amount of your 80% first mortgage and your down payment. Second loans come in two varieties: fixed second loans and home equity lines of credit.

Fixed seconds are amortizing loans. That means each payment includes both principal (the original amount borrowed) and interest. As the name indicates, fixed second mortgages have an interest rate that is fixed for the entire term (usually 30 years). The principal repayment schedule is calculated as if it is spread out over 30 years. However, fixed seconds usually require a "balloon" payment after 15 years. The balloon payment covers all money not yet repaid after year 15. To avoid making a balloon payment you can pay off the mortgage before year 15 or refinance it into a new one before it's due.

Home equity lines of credit are interest-only, adjustable loans. The interest rate is usually based on some margin over the prime rate of interest. The prime rate is the rate the Federal Reserve charges member banks to borrow money in order to meet withdrawal demands. The interest rate on a home equity line of credit will change any time the prime rate does. Home equity lines of credit usually allow you to borrow money and make payments of interest for the first 10 years of the loan. After that, the lender requires that you begin repaying principal. One advantage of a line of credit is that even if you pay the lender back you still have the option to draw money on the line again in the future.

Loans by occupancy type

Lenders provide the best interest rates and loan terms for properties that will be owner-occupied. The reasoning is that you will do whatever is possible to make your mortgage payment on your home because if you don't, you may lose it. Lenders provide similar interest rates and terms if you buy a vacation (second) home. However, for non-owner-occupied (investment) properties, lenders generally require a larger down payment and higher rate of interest. Lenders perceive the risk to be higher for investment properties, since you are not at risk of losing your primary residence if you don't repay the loan.

Prepayment Penalties

Some loans come with prepayment penalties which specify that you will be assessed a penalty if you repay the loan within a specific period of time. Most prepayment penalties are in effect between one and five years. You may want to accept a prepayment penalty on your loan because lenders will usually give you a lower your rate of interest in exchange. You may also not have a choice. Some loan programs require prepayment penalties because the lender perceives it is taking on a higher level of risk. By requiring a prepayment penalty the lender can minimize its risk by discouraging loan repayment during the first few years of the loan's term. A typical prepayment penalty is either 20% of the loan's outstanding balance or six months of interest, whichever is less.

It is important to note that it still may be possible to repay a portion of your loan even if you have a prepayment penalty. Generally, you can repay up to 20% of your loan's balance each year without incurring a prepayment penalty.